The BarkerLetter

Greetings investors

Don’t you love the doublespeak we get from Washington?

Last year President Bush made a scarcely publicised trip to South America, visiting Brazil and Colombia while studiously avoiding Venezuela. We were told he was there to talk about ethanol production, remember?

Yeah, and another purple cow just flew by!

We haven’t heard much about ethanol, but Brazil announced this week it was establishing a  sovereign fund in U.S. dollars.

Isn’t that nice?

Finance minister Guido Mantega said the move would stem a five-year rally in the Brazilian real and help rein in the country’s galloping GDP, now the highest in the Americas after the United States. He called it a piggybank of indeterminate size.

The decision surprised investors, who fear the fiscal impact will be huge and unpredictable because the government hasn’t said how it plans to buy dollars.

But it should crank up demand for the greenback — just in time for the U.S. elections, I’ll wager.

Oh, and here’s another little thing …

On the heels of that, Brazil’s state owned oil company, Petrobras, announced it has tied up 80 percent of the world’s deepest-drilling offshore rigs, ostensibly to explore the Tupi discovery, which has been described as the Western Hemisphere’s biggest potential offshore oil field.

Well whaddya know?

That puts the backs of the majors like Exxon Mobil up against the wall, and Petrobras is still negotiating for as many as 17 more vessels.

The company said it began signing multi year leases as far back as 2004, because it foresaw a shortage of deepwater vessels.

That’s some crystal ball they have over there at Petrobras, wouldn’t you say?

No word so far on the ethanol deal, though.

I wonder how that’s going?

The following is the popular explanation for rising oil prices and a falling dollar:

… the dollar became the easiest currency to spend in the global market after World War II, when America’s runaway wartime production capacity supplied Europe and Japan. However, oversupply of dollars in the ’50s led the Central Bankers to redeem them for gold under the terms of the 1944 Bretton Woods treaty. When gold reserves in the U.S. declined, President Nixon abandoned the gold standard.

It was thought the dollar’s influence would decline as traders relied more on emerging European and Asian currencies. Instead, it grew because OPEC quadrupled the price of oil and accepted U.S. dollars in payment. Demand for dollars soared.

From then on, the dollar was effectively backed by oil instead of gold. Because dollars can buy oil, countries that need to import it - which is just about everybody - will accept dollars for their exports. So America can export dollars, which cost nothing to produce, and receive real goods and services in return. That also ensures a continuous inflow of foreign investment to balance the trade deficit.

In the late 1970s, falling oil prices reduced the demand for dollars so an oil-price shock was manufactured, which raised demand again.

However, there is a bigger threat to dollar hegemony now. The Euro Zone has a bigger share of world trade than the USA, and it imports more oil. It offers higher interest rates without a huge foreign debt or trade deficit. OPEC members have began converting reserves to Euros, which has fueled demand and created a handsome increase in the value of their euro reserves.

The first OPEC member to show serious disloyalty to the dollar was Iran, which converted most of its currency reserves to euros during 2002. The second offender was Venezuela, which has proposed a barter system to trade oil for goods without the use of currency at all. The third and most blatant offender was Iraq, which converted its $10 billion “oil for food” reserve fund.

America subsequently occupied Iraq, and immediately stepped up its rhetoric against neighboring Iran, and also Syria, which coincidentally would also like to sell oil for euros because most of its imports are purchased with them …

That’s the popular dollar/oil/war conspiracy theory, and like most theories there is some truth to it. However, there are extenuating circumstances: For one, demand for oil has grown while the infrastructure for refining and delivering it has aged. This creates additional stresses which affect supply/demand, and hence pricing. Oil has also attracted speculators bent on driving the price even further.

I suppose most people think eventually the dollar will strengthen and oil prices will come down. I don’t see that happening unless the Eurozone’s influence diminishes, which is unlikely. The former Soviet Bloc nations will probably end up joining it, or would like to, along with Eurasian countries like Turkey. Imagine all of them trading in Euros!

Also, without petrodollars the only thing that keeps foreign investment humming along is a competitively priced currency. A cheap dollar is about the only thing America has going for it at the moment, so why would they want a stronger dollar?

Many experts believe America needs to reduce its dependance on oil, export more goods and services, service its foreign debt, and accumulate reserves of Euros. A cheaper dollar may be the first step towards that goal. Sure, it’s more expensive for New Yorkers to visit Paris. So let them stay a home!

Personally I like the Ameridollar idea, comprising the U.S., Canada and Mexico.

Be careful out there.
Kb

Greetings investors.

Here’s the odd thing — I think that Aurelian Resources (ARU.TSX) was actually going to try and mine their Fruta Del Norte gold discovery down on the Ecuador/Peru border.

Imagine that!

Oh sure, every junior intends to mine their own discoveries. But most don’t. That’s just window dressing, playing hard to get for the majors.

I’m not suggesting that exploration firms can’t be good miners. However, the exploitation of what I call ‘mineral discoveries of size’ in third world countries generally falls to major mining companies, and with good reason. The Newmonts, the Barricks, the Rio Tintos of the world have experience in working in ecologically sensitive countries populated by indigenous peoples and governed by populist leaders.

Does little Aurelian have the resources and experience - and perhaps most importantly, the time - for endless negotiations with multi levels of government, lobby groups, artesanial miners, indigenous peoples, environmentalists from near and far, guerillas, and anyone else who comes along and claims to be a stakeholder in the region? Perhaps they do. But I kind of doubt it. These projects take years to come to fruition. Does Aurelian have the wherewithal to go the distance? If I were a shareholder I’d be asking those hard questions.

The recent events in Ecuador were entirely predictable. The Ecuadorans weren’t going to let a junior miner walk away with billions of dollars in gold. It was inconceivable from the start.

There’s a very good reason why Newmont Gold’s 32.6 million ounce Yanacocha gold project is steaming ahead in nearby Peru. Actually several reasons: They have billions of dollars, they’ve been in the country for generations, and they could afford to wait 20 years to do it. Even so, they’ve had to undertake the very complex balancing act of guarding their operations from guerillas without alienating the local population. It’s no cakewalk.

Whoever gets to exploit Fruta Del Norte will find themselves in a similar role. They’ll be expected to provide many of the services traditionally administered by government, and probably for years to come. They’ll have to deliver power to villages, construct roads and schools and hospitals, maybe even arbitrate land disputes and/or provide law enforcement. Is Aurelian up for that?

Last year I wrote in this space that the company would never mine that project, that it would fall into stronger hands. That was speculation on my part, but I’m sticking by it.

Unfortunately, Aurelian is in the hard place now of having a rapidly escalating project to administer and pay for, while the political risk throughout Latin America grows daily.

I think they should have put themselves on the block last fall. Perhaps they did and nobody stepped up to the plate. Perhaps they were merely waiting to develop the project a little more to drive the price up. Perhaps they were waiting for a top in the gold price. Perhaps they were naive, or maybe they’d gotten a little high on themselves (hubris happens!)
But it’s a little late now, in any case.
I don’t mean to heap scorn on the company or its board of directors. It must be very difficult to let go of a project that was built from scratch into an exciting discovery with world class potential. They may have an entire gold district there that will eventually rival Yanacocha. Most exploration companies go through their entire life cycle without knowing what that feels like.
But I think they should have - for the sake of the shareholders.
Careful out there.

Kb